New Crowdfunding Considerations for Small Businesses

Crowdfunding is a hot topic of late, in part because the JOBS Act promises to bring significant changes to the way it works.

Among other things, the new legislation may allow small businesses to pursue a large, regulated pool of investors in place of the pledges or donations common in today’s crowdfunding campaigns. This could make crowdfunding a more accessible source of capital for small businesses — particularly through online platforms — by allowing more people to invest.

"A regulated environment will give entry to more investors who might see the option of investing more attractive than just giving a donation," says Tanya Prive, co-founder and COO of the crowdfunding site Rock the Post.

Prive points out that today’s pool of crowdfunding investors isn’t particularly crowded: It’s limited to accredited individuals whose net worth is at least $1 million (excluding their place of residence) or whose annual income is at least $200,000 per year (for a minimum of two consecutive years). These venture capitalists are sometimes called angel investors. However, many small businesses don’t have ready access to these investors or their capital, leaving them with bank loans as one of their few financing options.

The Intuit Small Business Blog recently asked Prive for her insights into the evolving area of crowdfunding.

ISBB: If I’m interested in crowdfunding my business, what can I do now to prepare for the coming changes?

Prive: For starters, small businesses that want to move forward with crowdfunding can begin to gather all the important documents needed to launch a campaign. Documents will include the financial status of the company, financial statements certified by an officer or accountant (depending on the amount of the offering), the company’s tax return for the most recent year, a business plan, and a capital structure explaining who owns what percentage of the company.

Will investors have a say in my business decisions? Can they tell me what to do?

Obviously, investors should always be considered from every perspective. However, voting rights and board seats are a different story. The most important factor here is the amount purchased and the percentage of equity that the individual will get in return, but typically the amounts that you'll be looking at will not represent a big ownership stake in the capital structure of the company. In any case, this will be specified by the terms of the investment inside each of the offerings.

What do I need to know about ownership structure and crowdfunding?

This is something that the SEC still needs to provide guidance on. At the moment, we know that small businesses will be able to have up to 2,000 investors and a maximum of 500 non-accredited investors. Once the grace period of 270 days (that the SEC has to regulate this matter) is finished, we should be more clear on how the ownership structure would work within the crowdfunding landscape.

Pledging campaigns differ greatly from investment campaigns, and it is important to keep in mind what motivates contributors in each case. Pledging comes down to three things:

People connect with the message and reason for the project;

People connect with the unique way in which the sponsor is trying to raise funding; and

People connect with some physical aspect of the project, such as the gifts they get from pledging.

When creating a pledging campaign, it is important to pull at the emotional heartstrings of potential contributors and to plan your pitch accordingly. Investments, however, are more of a strategic decision than an emotional one. So, with investment campaigns, it is important to present the business case professionally and fully. Here are three ways of doing so:

Have all the required paperwork handy for prospective investors to access;

Build an attractive business proposition; and

Establish credibility and trust of the executive team through well-written bios, references, and similar materials.